Those of us who follow macroeconomic statistics closely have been heartened by at least one development that US households have been saving more out of their (meagrely growing) income and repaying their debt. A recent Wall Street Journal story blows a neat hole through this one positive element of the otherwise dreary US economic landscape. Most of the reduction in debt came through forced debt write-offs and credit card charge-offs (http://blogs.wsj. com/economics/2010/09/18/number-of-the-week-defaults-account-for-most-of-pared-down-debt/).

Among other things, this information raises downside risks for consensus growth estimates for the US economy in 2010 or 2011. Corporate earnings cannot decouple themselves from the nominal gross domestic product (GDP) growth rate of the country. Therefore, with the prospect for real GDP growth dimming in the near term, the spotlight must fall on inflation. There we can point to the rising concern at the Federal Reserve over the risks of deflation. It needed no other proof than the estimate put out by one of its affiliates. The Federal Reserve Bank of Cleveland publishes its median consumer price index inflation rate. It is barely at 0.5%—50 basis points away from entering the deflation zone. In other words, the risk of deflation is not trivial.

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In response to these mounting deflation concerns, the Federal Reserve signalled its readiness to act in “conventional" fashion again. It succeeded in easing financial conditions in the US with this announcement. The dollar has weakened, interest rates have declined and stocks have rallied. Whether it would mean any real improvement in the economy and what would be the side effects are questions for which the Federal Reserve has no answer.

In fact, the more pressing question for investors is whether the true bottom of the dollar is in the immediate or in the medium-term future. The rest of the world is not in a position to take a benign view of US dollar weakness as it did in 2003-07. Japan has seen its central bank balance sheet expand the least since the crisis erupted in 2008. In that sense, it has more scope than either the Bank of England or the European Central Bank to pursue unsterilized intervention to weaken the yen.

Indications are that it would do so regardless of what its trading partners think. Whether warranted or not, Japan has not taken kindly to China’s purchase of Japanese government bonds. Certainly, after China’s aggressive pursuit of its fishing boat captain arrested by Japan, Japan is even more unlikely to let any strengthening of the yen due to actions by China go unattended.

Other emerging markets are in a worse quandary. Any intervention on their part to buy up the dollar and to delay their currency appreciation would boost their reserves no doubt. However, such reserves are bound to lose value, given the US’ pursuit of a weaker dollar. Further, they have also to decide on whether such interventions should be sterilized or the money supply should be allowed to remain in the system.

If the latter, then the effect on asset price inflation and price levels of consumption goods and services has to be borne in mind. The recent spurt in prices of agricultural commodities has as much to do with the actions of global central banks as it is due to the scorching summer in Russia and devastating floods in Pakistan around the same time.

The other tool that would increasingly be talked about and deployed is capital controls. Otherwise, emerging nations are ill-equipped and/or disinterested in using the flows to augment the supply side of their economies. Capital flows spurred on by low interest rates seek the most speculative investment rather than investments determined by serious net present value considerations. The result is there for all to see in real estate prices in Asia-Pacific.

As early as at the end of the first quarter of this year, The Economist estimated many real estate markets in Asia-Pacific to be overvalued by as little as 20% to as high as 61% (

In the final analysis, emerging markets would deploy in some measure all of these—currency appreciation, intervention, reserve accumulation, sterilization, capital controls, fostering asset bubbles, tolerating higher inflation—and thus contributing to stratifying their societies further. In other words, they are unlikely to let the West have a free run at the race to the bottom for their currencies.

Therefore, it is not a surprise that after ridiculing the lack of value in the “barbaric relic", some commentators are changing their tune. Is this a sign of a market top for gold or a sign of more upside for gold prices as the gold bears throw in the towel? Bare Talk has more sympathy for the latter view.

It is a matter of time before the US dollar index, DXY, breaks the previous low of 71-plus. That is some 10-15% away. That also defines the intermediate stage upside potential—give or take a few percentage points—for gold.

V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at